Wild Market Has Spenders Thinking Twice

After losing $2 million on paper in last week’s stock market carnage, Joe Zuffoletto immediately put a hold on plans to buy a Newport Beach house.

And suddenly, the single-engine airplane he was going to snap up for $379,000 seemed too pricey. So Zuffoletto started haggling with the plane’s seller.

“It’s like getting a body blow,” the 61-year-old executive said of the market’s plunge. “It took the wind out of me.”

Although Zuffoletto recouped some of his paper losses earlier this week, the experience has left him questioning his spending. “Do I really want to buy all these things? Do I really need all these things? Do I want to extend myself?” he asked. “And the answer was no.”

Extraordinary advances in the stock market in the last few years have made it easier for Zuffoletto and many other people to spend heartily, especially on luxury goods. Economists call it the “wealth effect.”

But the stock market’s biggest one-day point loss ever last Friday, followed by seesawing activity this week, has left many people feeling less wealthy and more nervous.

Whether that will dampen spending, not only for the wealthy but also across the vast middle class, whose fortunes are tied more than ever to Wall Street, is not yet clear. But some economists say the market’s ongoing volatility could set in motion a reversal of the wealth effect, which would have widespread economic repercussions.

“If all of a sudden there’s more uncertainty about where [the stock market] is going, and there certainly seems to be, that alone would probably temper the pace of consumer spending,” said Tom Lieser, executive director of the influential UCLA Anderson Forecast. “You wouldn’t necessarily need an outright crash.”

Even before the stock market’s latest plunge, consumer confidence had begun creeping downward, declining for the last two months from a record high in January, according to a survey by the Conference Board business group.

Earlier this month, the board’s index of leading indicators, which predicts the economy’s behavior over three to six months, showed its sharpest monthly decline in four years, despite what experts say is a healthy underlying U.S. economy.

Most economists agree that a $1 increase in wealth leads to a one-time 3-to-4-cent boost in consumer spending.

By the same token, a $1 decline would have the reverse effect. That may not seem much, but analysts figure that, collectively, it has been boosting economic output by as much 2%.

And nowhere are the stakes as high as in California.

With its disproportionately high share of high-tech companies and workers paid with stock options, the state has benefited richly from the long bull market. Consumer spending by Californians last year jumped by nearly double digits, providing a huge lift to retailers and to state and municipal budgets that rely largely on sales tax revenue.

And capital gains have provided an unexpected windfall for California government coffers. Last year, an estimated 9% of the state’s general fund revenue, about $6 billion, depended on capital gains, most of which was tied to stock transactions, said Bruce Smith, an economist with the California Finance Department.

Economists were not prepared yet to revise their strong near-term forecasts for California’s economic growth after the latest market decline.

But certainly a more prolonged market slump would hit California harder than most any other state.

And it’s not just the wealthy who would feel the pain. Today, about half of all American households own stock in one form or another. And even those who don’t own stocks increasingly link the health of the overall economy to Wall Street’s gyrations.

Should the market shift into a prolonged downturn, it would clearly hurt start-up businesses, many in the high-tech industries that have powered California’s economic growth. A slowdown in these businesses would mean a slowdown in the state’s economy, Smith said.

“It affects no state economy more than California,” he said. “We have been looking hard, trying to [understand] what happened on the way up so we can help the administration with what will happen on the way down, if it happens.”

Part of the difficulty of predicting what might happen if the wealth effect dissolves into the “maybe-I’m-not-so-wealthy-after-all” effect is that psychology plays a huge role in whether a consumer consumes.

“The wealth effect is a feeling,” Smith said. And Joe Zuffoletto illustrates that fact perfectly.

The Colorado resident, who vacations in Orange County, pulled back on the home and airplane purchases even though he did not plan to use his stock proceeds to make them. He is still planning to buy a BMW and a motorboat.

“There was definitely a psychological thing,” said Zuffoletto, chief executive of Colorado-based AC Systems Inc., which sells air conditioners for computer rooms. “If I was still worth this [much] on paper, I’d feel better about buying these things.”

In a negative wealth effect, the first cuts will be in discretionary spending on such big-ticket items as homes, luxury cars and boats--products that have had spectacular sales in recent times.

Sales of recreational vehicles and boats, for example, have been increasing at nearly double the pace of other taxable goods, according to state figures.

And businesses that market vacations and cruises have been booming, as have fine restaurants.

Attendance at the 27th annual Newport Harbor Boat Show in Newport Beach last week was higher than ever, said manager Duncan McIntosh.

But although most people still seemed eager to buy, there was an undercurrent of concern over the stock market’s volatility.

“They were not overjoyed with what was happening,” said Gordon Passey, a West Coast manager for Fairline motor yachts, referring to Wall Street’s sell-off.

Passey said this week that he hadn’t received any cancellations, but some luxury car dealers said they saw an immediate slowdown following last Friday’s market plunge.

Longo Toyota & Lexus in El Monte reported that sales last weekend dropped about 30% below a normal Saturday and Sunday. “I think it was a combination of the stock market and the tax deadline,” said Tom Rudnai, general manager. But he said he remains optimistic about sales.

Even before the market troubles, car sales had been expected to slow a bit this year, following a frenetic pace in recent months. In January and February, sales of cars and small trucks in California jumped more than 30% from a year earlier--double the nationwide increase.

But as some economists see it, any measurable reversal in the wealth effect would not be seen right away.

In some cases, financial shifts have been subtle.

The stock market dive didn’t stop Fullerton resident Fredrick Culmann from buying a $46,000 pearly white Cadillac Seville on Saturday. But instead of selling some stock to buy the car outright, he decided to finance part of the purchase.

Still, the 65-year-old owner of Culmann Construction & Engineering said he’s not worrying about where the stock market will head next.

“I don’t even think about it,” he said.

But a lot of home buyers are thinking about it, said Michael Dreyfus, an agent with Prudential California Realty in Corona del Mar, which specializes in upscale coastal properties.

“More so than ever, the fluctuations in the market do affect confidence,” he said. “And confidence is a big force in a highly appreciating real estate market. Whether you’re going to pay more than the last guy is really based on where you think things are going.”

Dreyfus said he hasn’t yet lost any deals, but one sale was stalled in escrow, a delay that the buyer blamed on the market’s plunge.

In fact, this week could have been a slow one for agents if the market hadn’t bounced back, he said.

“Everybody stops and watches what’s going to happen next [on Wall Street] before they go out and look at a house,” he said.